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Liability  and  Workmen's 
Compensation  Insurance 


ON  THE 


Reciprocal  or  Inter-Insurance  Plan 


By 


P.  Tecumseh  Sherman 


Copyright,  1 9 1 6,  by 
P.  TECUMSEH  SHERMAN 

New  York. 


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LIABILITY  AND  WORKMEN'S 

COMPENSATION  INSURANCE 

ON  THE 

RECIPROCAL  OR  INTER-INSURANCE  PLAN 


In  an  address  delivered  before  the  Annual  Convention  of  Insurance 
Commissioners,  September  23rd,  19 15,  Hon.  John  S.  Patterson,  the 
Commissioner  of  Insurance  and  Banking  of  the  State  of  Texas,  said : 

"During  19 14  the  people  of  Texas  were  swindled  out  of  not 
less  than  one  million  of  dollars  by  so-called  inter-insurance,  to 
say  nothing  of  the  unpaid  losses.  There  were  forty-nine  holding 
certificates  from  the  Department  when  I  came  into  office  on 
January  23rd  of  this  year;  to-day  there  is  not  a  certificate  in 
force.  Out  of  the  above  number  there  were  some  transacting 
an  honest  insurance  business;  others  knew  no  limit  to  their 
rascality.  Texas  can  point  with  pride  to  its  cemetery  of  dead 
reciprocals,  to  say  nothing  of  those  in  the  hands  of  the  under- 
taker; but  neither  my  State  nor  yours  can  point  with  pride  to 
any  law  that  will  bring  these  swindlers  to  justice.  Those  that 
are  now  languishing  in  our  jails  are  there  by  indictment  of  a 
Federal  grand  jury  for  the  use  of  the  mails  to  defraud." 

A  somewhat  similar  stand  against  reciprocals  and  inter-insurers  has 
been  taken  very  recently  also  by  the  Insurance  Commissioner  of  Ohio. 

How  reciprocal  insurance  may  and  sometimes  does  operate  to 
defraud  is  illustrated  in  the  Bulletin  of  the  West  Virginia  Insurance 
Department,  February,  19 14.  A  firm  in  Parkersburg,  W.  Va., 
having  suffered  a  loss  of  about  $30,000,  insured  under  a  policy  of  a 
reciprocal  indemnity  exchange,  sought  to  sue  because  payment  of  its 
claim  was  refused.  They  then  found  that  the  exchange  itself  was 
not  liable,  but  that  they  were  in  fact  insured  piece-meal  by  the 
other  subscribers  to  the  exchange,  of  whom  there  were  several 
hundred  scattered  over  many  States,  each  one  of  whom  was  liable 
for  only  about  $70  or  $80.  The  exchange  refused  to  disclose  the 
names  and  addresses  of  these  subscribers;  and  in  any  event  it  would 
probably  have  cost  about  as  much  as  the  amount  involved  to  collect 
such  a  multitude  of  small  claims  and  to  carry  on  the  litigation  inci- 
dentally necessary.  Consequently  the  policy  was  almost  worthless. 
In  this  instance  a  relatively  low  premium  rate  and  pleasing  divi- 
dends made  the  insurance  eminently  satisfactory  to  the  policyholder 
until  a  substantial *k)$s;  occurred;  .- T^en  the  cat  was  out  of  the  bag 
and  the  policyholder* "discovered7  tfiaf  the  reason  why  his  supposed 
insurance  was  so*.  pdea#3in,giy  -cheap  was.  that  it  was  not  true  insurance 
at  all.  .  >    .  •     .;..;/•.,." 

According  to  public  reports  a  somewhat  similar  experience  has 
been  encountered  by  the  Forest  Mills  Timber  Company,  of  Comiplex, 
British  Columbia,  with  a  policy  in  a  foreign  reciprocal  exchange. 
The  Forest  Mills  Company  having  suffered  a  fire   loss  of  over  a 


hundred  thousand  dollars  and  the  exchange  having  refused  payment, 
the  Company  sued  one  of  its  co-subscribers,  another  lumber  company 
in  British  Columbia,  for  the  latter's  share  of  the  liability,  and  was 
met  with  the  following  defences :  ( I )  That  the  exchange  had 
no  right  to  do  business  in  British  Columbia.  (2)  That  it  was 
ultra  vires  for  the  plaintiff  to  enter  into  a  contract  of  inter-insurance. 
(3)  That  it  was  ultra  vires  for  the  defendant  to  enter  into  such  a 
contract.  Whether  or  not  these  defences  are  valid  under  the  law  of 
British  Columbia  is  uncertain.  But  it  is  certain  that  what  the 
Forest  Mills  Company  bought  when  it  paid  for  its  policy  was  not 
true  insurance,  but  only  a  gambling  chance  in  litigation  on  questions 
of  law,  and  that  its  prospects  of  ever  collecting  the  face  value  of 
that  policy,  or  anything  near  it,  over  and  above  expenses,  are  very 
dubious,  regardless  of  the  merits  of  its  claim  to  indemnity. 

A  further  experience  in  the  same  line  was  reported  by  Mr.  Arthur 
Hawxhurst,  insurance  manager  for  Marshall  Field  &  Co.,  in  an 
address  before  the  Insurance  Society  of  New  York,  April,  19 16,  in 
which  address  Mr.  Hawxhurst  characterized  the  usual  reciprocal 
contract  as  a  "great  soft  snap"  for  the  manager  of  the  exchange, 
scored  liability  insurance  on  the  reciprocal  plan,  and  warned  business 
men  to  stick  every  one  to  his  own  trade  and  not  to  venture  on  the 
side  into  the  little-understood  and  dangerous  field  of  reciprocal 
insurance. 

Reciprocal  or  inter-insurance  (both  terms  meaning  the  same  thing) 
is  not  necessarily  so  bad.  Why  then  is  it  that  this  form  of  insurance 
so  frequently  leaves  the  policyholder  in  the  lurch?  The  answer  is 
that,  whereas  fraudulent  and  unsound  practices  are  generally  pre- 
vented in  other  forms  of  insurance  by  salutary  public  regulations, 
the  promoters  of  reciprocal  insurance  have  succeeded  in  many  States 
in  obtaining  exemption  from  the  greater  part  of  the  regulations 
common  to  other  insurance — indeed  in  some  fifteen  States  they  have 
obtained  special  legislation,  known  as  the  "standard  reciprocal  law," 
which  not  only  exempts  them  from  all  effective  regulation  and  super- 
vision but  also  positively  protects  them  in  unfair  and  fraudulent 
practices.  In  this  paper  it  will  be  shown  how  that  law  permits 
the  promoters  of  so-called  reciprocal  insurance,  if  they  be  unscrupu- 
lous, to   impose  upon  their  customers. 

WHAT  IS  RECIPROCAL  INSURANCE? 

Reciprocal  or  inter-insurance  is  a  hybrid  between  Lloyds  insur- 
ance and  mutual  insurance,  in  which  the  stronger  features  of  each 
of  these  older  forms  of  insurance  are  eliminated.  In  reciprocal 
insurance  the  members  or  subscribers,  through  an  attorney-in-fact, 
mutually  contract  to  indemnify  one  another  against  loss,  each  mem- 
ber binding  himself  as  an  insurer  severally  and  not  jointly,  and  each 
member  limiting  his  liability  either  to  some  fixed  proportion  of  each 
single  loss,  or  in  the  aggregate  to  some  fixed  proportion  of  his 
annual  premium,  or  sometimes  both  ways.  Such  insurance  is  usually 
promoted  by  a  person — sometimes  a  corporation — operating  an  "ex- 
change," who  secures  from  the  subscribers  powers-of-attorney  con- 
stituting him  their  attorney-in-fact,  with  broad  powers  to  enter  into 
indemnity  contracts  for  them  and  to  manage  the  business,  but  without 

3 

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personal  responsibility  on  his  part  for  the  payment  of  the  indemnities 
or  for  anything  else  of  importance.  In  remuneration  for  his  services 
the  attorney-in-fact  usually  contracts  with  the  subscribers  that  he 
may  deduct  some  large  percentage  from  their  premiums.  Conse- 
quently the  primary  interest  of  the  attorney  is  to  secure  promptly  a 
large  volume  of  premiums.  If  his  interest  for  immediate  profit  should 
conflict  with  methods  and  practices  requisite  to  secure  the  ultimate 
success  of  the  insurance  scheme  and  to  do  justice  to  and  among  his 
subscribers,  he  is  under  every  temptation  to  sacrifice  the  latter.  In 
other  words  the  subscribers  assume  all  the  risks  but  confide  the 
entire  management,  subject  to  no  check  or  control,  to  a  stranger 
with  primarily  antagonistic  interests. 

It  is  sometimes  claimed  that  a  reciprocal  exchange  operates  on 
practically  the  same  basis  as  "Lloyds  insurance."  In  form  there  is 
some  resemblance  between  them,  but  in  substance  they  are  radically 
different.  Every  one  of  the  existing,  reputable  Lloyds  exchanges 
is  an  association  of  well  known  and  wealthy  firms  and  individuals, 
doing  business  at  one  place,  which,  through  its  various  members,  each 
acting  individually  for  himself  and  as  agent  for  the  others,  sells 
insurance  to  the  public,  each  member  of  the  association  assuming 
some  fixed  part  or  proportion  of  the  risk  on  each  policy.  Such 
associations  differ  from  reciprocal  exchanges  in  that  they  are  managed 
by  the  members  and  not  by  an  irresponsible  third  party,  in  that 
their  members  are  experienced  insurers  by  profession  and  are  en- 
gaged for  profit  in  the  business  of  insuring  third  parties  instead  of 
one  another,  and  in  that  the  members  are  known  to  the  policyholders 
and  are  highly  responsible  and  readily  accessible  in  the  event  that 
suits  on  a  policy  become  necessary.  Moreover  it  is  generally  recog- 
nized that  a  "Lloyds"  policy  is  not  suitable  for  workmen's  compensa- 
tion, with  its  chances  of  liabilities  running  for  years  or  even  for  a 
generation.  To  cover  such  long  continuing  liabilities  something 
more  stable  than  a  short-lived  association  is  desirable.  For  such  lia- 
bilities only  an  incorporated  insurance  carrier  can  fill  the  bill.  Indeed, 
after  having  enjoyed  a  craze,  "Lloyds"  is  not  now  regarded  as  a 
desirable  method  of  insurance,  save  in  some  few  lines,  and  then 
only  under  exceptional  conditions,  which  conditions  are  now  in 
fact  fulfilled  by  only  a  few  surviving  groups  of  insurers  doing 
business  each  in  some  great  financial  or  commercial  center. 

RECIPROCAL    POLICIES    AND    POWERS    OF    ATTORNEY 

Having  now  seen  in  a  general  way  what  reciprocal  insurance 
is  and  is  not,  let  us  take  up  the  so-called  standard  reciprocal  law, 
and  see  how  it  opens  the  door  to  frauds  and  impositions  upon  the 
public. 

In  the  first  place,  as  to  the  policy  and  power-of-attorney :  Who- 
ever draws  a  contract  naturally  draws  it  to  favor  himself,  with 
little  regard  to  the  interests  of  the  other  party;  and  where  the  party 
drawing  the  contract  is  an  expert  in  the  subject  matter  and  the  other 
party  is  comparatively  ignorant,  very  "raw  deals"  frequently  result. 
Insurance  being  a  peculiarly  technical  subject,  experience  has  shown 
that  the  public  is  peculiarly  liable  to  be  imposed  upon  by  insurance 
contracts.     Therefore,  generally,  the  laws  relating  to  fire  and  com- 


pensation  insurance  provide  that  every  policy  and  all  important 
incidental  papers  constituting  the  contract  shall  be  in  some  standard 
and  approved  form,  from  which  all  unfair  and  "trick"  clauses  have 
been  carefully  excluded  by  the  public  authorities.  And  this  form  of 
regulation  is  steadily  spreading.  Honest  insurers  favor  rather 
than  object  to  it.  But  under  the  reciprocal  law,  the  policies  and 
powers-of-attorney  used  in  the  operations  of  a  reciprocal  exchange 
are  exempted  from  any  such  regulation,  and  the  attorney-in-fact 
is  allowed  to  draw  them  to  suit  his  own  interests  and  in  a  form 
to  mislead  his  customers.  It  is  true  that  the  reciprocal  law  requires 
the  attorney-in-fact  to  file  copies  of  his  forms  of  policies  and  powers- 
of-attorney  with  the  Insurance  Commissioner;  but  it  does  not  re- 
quire the  approval  of  such  forms  by  such  Commissioner.  No  matter 
how  unfair  and  misleading  the  Commissioner  may  perceive  their 
terms  to  be  he  must  meekly  accept  and  file  them,  and  let  the 
swindle  proceed.  In  other  words,  this  requirement  of  the  statute 
is  worse  than  no  regulation  at  all,  for  it  is  a  sham  and  a  deception. 

THE  RECIPROCAL  EXCHANGE 

In  order  to  operate  under  other  insurance  laws,  generally,  there 
must  be  a  corporation  or  something  like  it,  with  responsible  and 
bonded  officers,  with  funds  in  certain  specified  forms,  deposited 
in  certain  places,  controlled  by  certain  public  authorities,  etc.;  in 
short  there  must  be  some  tangible,  stable,  responsible  and  publicly 
regulated  organization  obligated  to  pay  the  loss  on  its  policies. 

Under  the  reciprocal  law,  however,  all  that  is  required  of  the 
attorney-in-fact,  in  order  to  secure  a  certificate  entitling  him  to  do 
business,  is  that  he  shall  file  an  affidavit  stating  the  location  of  his 
"exchange,"  that  he  has  a  certain  number  of  subscribers  applying 
for  policies  covering  risks  aggregating  a  certain  amount,  that  he  has 
on  deposit  at  least  $25,000  available  for  the  payment  of  losses, 
and  a  few  other  unimportant  particulars.  He  need  give  no  security 
and  need  not  deposit  his  money  anywhere  in  particular — indeed  he 
need  not  even  say  where  it  is, — he  need  not  specify  his  subscribers, 
and  he  is  expressly  relieved  from  any  obligation  to  furnish  their 
names  and  addresses.  Consequently,  the  only  substantial  obligation 
as  to  him  is  that  he  shall  fix  upon  some  definite  place  for  his  ex- 
change. As  to  his  subscribers,  he  is  required  to  make  the  Insurance 
Commisisoner  their  agent  for  the  acceptance  of  legal  process;  but, 
because  he  need  not  furnish  the  names  and  addresses  of  any  of 
such  subscribers  and  because  judgment  upon  such  service  would  be 
ineffective  against  persons  unknown  and  unnamed  and  invalid  against 
subscribers  residing  outside  the  State,  this  requirement  is  almost 
worthless  to  creditors  of  the  exchange. 

Thus  by  this  statute  an  irresponsible  exchange — a  mere  place, 
where  no  funds  need  be  kept — is  substituted  for  a  responsible  cor- 
poration, and  special  obstacles  are  created  in  order  to  prevent  the 
responsible  subscribers  from  being  reached. 

It  is  true  that  the  attorney-in-fact  may  appoint  a  responsible  treas- 
urer or  board  of  advisers.  But  the  law  does  not  so  require. 
Though  tTie  usual  power-of-attorney  provides  that  an  advisory  board 
or  committee  shall  be  appointed,  it  gives  the  attorney,  either  expressly 


or  by  indirection,  either  the  right  to  select  the  members  or  the 
means  to  eliminate  objectionable  members,  and  confers  upon  the 
members  no  power  to  supervise  or  to  interfere  with  the  management 
and  no  responsibility  therefor.  Such  provisions  are  most  blatant 
devices  to  deceive  subscribers  and  to  withdraw  their  attention  from 
the  fact  that  the  standard  reciprocal  law  secures  them  not  even 
the  right  to  look  into  the  operations  of  their  exchanges. 

CONTINUED  SECURITY 

Once  authorized  to  commence  business,  a  company  operating  under 
other  insurance  laws  generally  is  required  by  such  laws  to  maintain 
its  organization,  its  capital,  its  deposits,  etc.,  unimpaired,  besides 
building  up  reserves  to  cover  its  accumulating  liabilities;  and  the 
Insurance  Commissioner  is  given  the  authority  and  the  means  to 
see  that  it  does  so.  If  at  any  time  it  is  in  default  in  any  of  these 
respects  or  the  Insurance  Commissioner  has  good  reason  to  believe 
that  its  solvency  is  seriously  impaired,  generally,  he  may  dissolve  it 
or  revoke  its  certificate. 

Not  so  with  reciprocal  exchanges  in  those  States  wherein  the 
standard  reciprocal  law  is  in  force.  That  law  exempts  such  ex- 
changes from  all  practical  requirements  as  to  reserves  and  from  all 
effective  supervision,  its  provisions  which  seem  to  provide  for  a 
reserve  and  for  supervision  being  cunningly  devised  shams. 

Nominally  the  reciprocal  law  provides  that  the  Insurance  Com- 
missioner may  revoke  or  suspend  the  certificate  of  an  exchange  "in 
case  of  breach  of  any  of  the  conditions  imposed  by  this  act."  But 
the  only  conditions  imposed  by  the  act  amount  to  nothing.  They 
are  as  follows: 

First.  "There  must  be  maintained  at  all  times  as  a  reserve  a 
sum  in  cash  or  convertible  securities"  equal  to  50%  of  the  balance 
of  premiums  or  deposits  collected  for  the  current  year  after  deducting 
the  attorney's  commissions,  at  no  time  less  than  $25,000.  But 
where  must  such  reserve  be  maintained?  The  answer  is  that  it 
may  be  maintained  anywhere — in  a  distant  State,  spread  around 
among  or  kept  moving  between  many  banks  in  distant  States,  in 
the  attorney's  pocket,  or  anywhere  else  he  may  select  to  hide  it 
from  his  subscribers  and  creditors.  Indeed  there  is  nothing  in  the 
law  practically  to  prevent  his  using  the  same  sum  of  money  or  bunch 
of  securities  as  the  reserve  for  each  of  a  whole  chain  of  exchanges. 
It  is  manifest  that  this  provision  is  not  conducive  to  security,  but 
rather  to  the  contrary. 

Second.  The  attorney-in-fact  must  make  an  annual  report  to  the 
Insurance  Commissioner  showing  that  the  financial  condition  of  af- 
fairs at  his  exchange  is  "in  accordance  with  the  standard  of  solvency 
provided  for  herein,"  and  stating  the  premiums  or  deposits  collected, 
the  losses  paid,  the  amounts  returned  to  subscribers  and  the  amounts 
retained  for  expenses.  There  are  two  palpable  jokers  in  this  pro- 
vision which  mark  it  as  a  sham.  In  the  first  place  there  is  no 
standard  of  solvency  provided  for  in  the  law.  In  the  second  place 
the  items  to  be  reported  do  not  include  the  one  most  necessary  item 
that  should  be  reported  to  determine  solvency,  namely  the  amount  of 


outstanding  liabilities.  Under  this  system  of  fake  reporting  an  ex- 
change may  be  all  the  time  piling  up  a  deficit  at  a  startling  rate, 
and  yet  every  year  be  able  to  file  a  nominally  true  report  indicating 
to  the  contrary  that  it  is  solvent.  The  law  then  goes  on  and  gives 
to  the  Insurance  Commissioner  authority  to  investigate  directly 
into  the  business  affairs  and  assets  of  the  exchange,  "as  shown  at 
the  office  of  the  attorney  thereof."  That  looks  like  full  power  of 
supervision.  But  in  reality  it  is  not.  If  the  Commissioner  cannot 
find  out  anything  at  such  office,  he  is  at  the  end  of  his  certain 
authority.  And,  on  the  other  hand,  if  he  does  find  out  something  at 
such  office,  no  matter  how  bad  it  may  be,  no  matter  how  insolvent 
it  may  disclose  the  exchange  to  be  and  no  matter  how  crooked  it  may 
show  the  exchange's  practices  to  be,  he  may  not  be  able  to  do  any- 
thing effective  about  it.  He  cannot  wind  up  the  exchange.  He 
cannot  revoke  its  certificate;  but  on  the  contrary  it  can  continue  to 
trade  on  the  certificate,  using  such  certificate  to  deceive  the  public 
into  believing  that  it  has  the  approval  of  the  Commissioner.  And 
he  may  not  be  able  even  to  warn  the  subscribers;  for  the  attorney 
cannot  be  made  to  furnish  him  the  names  and  addresses  of  any 
subscribers. 

In  this  connection  it  should  be  noted  that  the  crusade  in  Texas 
against  reciprocal  swindlers,  described  in  the  opening  quotation  in 
this  paper,  was  under  a  different  form  of  law,  which  contained  a  pro- 
vision empowering  the  Insurance  Commissioner  to  revoke  the  cer- 
tificate of  a  reciprocal  exchange  for  "reasonable  cause."  And 
similar  provisions  in  the  Ohio  law  enabled  the  Commissioner  of 
that  State  to  act  to  stop  abuses.  In  contrast  the  standard  reciprocal 
law  contains  no  provision  of  the  kind,  but  on  the  contrary  is  so 
drawn  as  to  prevent  the  Insurance  Commissioner  from  interfering 
with  dishonest  practices.  It  is  in  effect  an  express  license  to  swindle. 
Third.  Whenever  demanded  the  attorney-in-fact  must  report 
under  oath  to  the  Insurance  Commissioner  that  he  has  made  certain 
inquiries  into  the  commercial  rating  of  his  subscribers  and  that  from 
such  inquiries  "it  appears  that  no  subscriber  has  assumed  on  any 
single  risk  an  amount  greater  than  10%  of  the  net  worth  of  such 
subscriber."  This  provision  is  pure  humbug.  It  is  a  parody  on  the 
provision  usual  in  insurance  laws  which  forbids  a  stock  company  to 
carry,  without  reinsurance,  any  single  risk  in  excess  of  10%  of  its 
paid  up  capital.  It  does  not  prevent  a  policy  being  written  on  a 
single  risk  out  of  all  proper  proportion  to  the  exchange's  resources; 
for  it  permits  an  exchange  with  only  $25,000  available  for  the 
payment  of  losses,  to  issue  a  policy  for  $2,000,000  on  a  single  risk, 
if  it  have  400  subscribers  no  one  of  whom  "appears"  to  the  attorney- 
in-fact  to  be  worth  less  than  $50,000.  It  does  not  protect  the  insured 
by  limiting  the  amount  of  his  policy  to  an  amount  which  he  can 
possibly  recover;  for  the  powers-of-attorney  under  which  the  ex- 
change's policies  are  executed  may,  for  example,  provide  that  the 
liability  of  any  one  subscriber  shall  be  limited  to  the  amount  of  his 
annual  premium,  and  the  aggregate  of  such  annual  premiums  of  all 
the  subscribers  may  be  much  less  than  the  amount  for  which  a  policy 
may  be  written  under  this  provision.  Nor  does  it  protect  the  indi- 
vidual subscriber  by  limiting  the  amount  for  which  he  may  be  made 


liable  as  an  insurer  on  any  single  risk  to  10%  of  his  worth;  for  it 
merely  prescribes  what  the  attorney-in-fact  must  do  as  a  condition 
to  his  right  to  continue  business,  and  does  not  purport  in  any  way  to 
affect  or  limit  the  liabilities  of  subscribers,  which  liabilities  must  be 
limited,  if  at  all,  by  the  terms  of  their  contracts. 

THE  SUBSCRIBER'S  CONTRACT 

Now,  having  seen  what  the  usual  reciprocal  law  provides,  it 
remains  to  analyze  the  usual  contract  under  such  law.  Generally 
that  contract  is  contained  in  a  power-of-attorney  and  a  policy  of 
insurance. 

The  power-of-attorney,  which  is  executed  by  the  subscriber  and 
delivered  to  the  attorney-in-fact,  empowers  the  attorney  to  bind  the 
subscriber  to  a  large  number  of  contracts,  whereunder  the  subscriber 
agrees  to  indemnify  his  associates  against  loss,  and  to  do  many  other 
things  incidental  to  the  business  of  insurance  as  the  agent  of  the 
subscriber. 

Usually  or,  at  least,  commonly  it  contains  also  provisions  to  the 
following  effect: 

i.  That  the  attorney  may  deduct  some  fixed  percentage  of  the 
.subscriber's  gross  premiums  for  the  former's  services  and  expenses. 

2.  That  the  attorney  may  deduct  some  further  percentage  of 
ithe  subscriber's  gross  premiums  to  pay  for  inspection  of  risks,  ad- 
justment of  losses,  etc. 

3.  That  the  attorney  shall  select  and  appoint  some  reasonable 
number  of  subscribers  as  an  advisory  committee  and  may  deduct 
reasonable  fees  and  expenses  for  them  out  of  the  premiums. 

4.  That  the  liability  of  the  subscriber  on  any  one  contract,  or 
on  all  contracts,  executed  for  him  by  the  attorney,  shall  be  limited  to 
the  amount  of  his  annual  premium  or  deposit,  or  to  some  other 
definite  sum. 

5.  That  the  subscriber  shall  be  liable  severally  and  alone  for  his 
share  of  any  loss  he  insures,  and  not  jointly  with  the  other  sub- 
scribers; and  that  the  subscribers  shall  have  no  joint  funds  and  no 
power  to  act  for  or  to  bind  one  another. 

6.  That,  except  as  above,  the  attorney  shall  have  no  ownership 
or  property  interest  in  the  premium  or  deposit  funds;  and  that  the 
subscribers  shall  have  no  ownership  or  property  interest  in  the 
business,  office  or  office  property  of  the  attorney  or  of  his  exchange. 

7.  That  either  party  may  revoke  the  power-of-attorney  and  the 
policy  upon  some  specified  number  of  days'  written  notice;  and  that 
upon  the  expiration  of  such  time  the  subscriber's  equitable  pro  rata 
part  in  the  premium  and  deposit  funds  shall  be  determined  by  the 
attorney  and  returned  to  the  subscriber. 

The  policy,  on  the  other  hand,  is  executed  by  the  attorney  and 
delivered  to  the  subscriber.  Usually  it  binds  the  other  subscribers 
to  the  exchange  each,  severally,  to  indemnify  the  policyholder  for 
some  part  or  proportion  of  any  loss  he  may  suffer,  not  exceeding, 
however,  the  amount  of  one  annual  premium,  and  the  aggregate 
being,  of  course,  limited  to  the  amount  specified  in  the  policy.  It 
also  usually  provides  that  on  any  claim  under  said  policy  a  test  suit 

8 


must  first  be  brought  against  some  one  of  such  other  subscribers  and 
be  determined,  before  any  more  or  all  of  them  may  be  sued. 

Taking  this  contract  as  a  whole  it  is  remarkable  for  its  one- 
sidedness.  It  secures  to  the  attorney  a  high  and  certain  remunera- 
tion and  extensive  powers,  but  imposes  upon  him  no  corresponding 
risks,  duties  or  obligations.  He  takes  the  subscribers'  money  without 
mention  of  bond  or  security.  He  does  not  undertake  to  keep  the 
funds  with  any  responsible  depository.  He  does  not  contract  to  keep 
books  of  account  or  accessible  lists  of  his  subscribers.  He  does 
not  undertake  to  follow  any  definite  policy  or  to  conform  to  any 
definite  standards  in  his  operations.  And  he  most  distinctly  does  not 
assume  to  continue  his  exchange  after  it  ceases  to  be  profitable  to 
him  personally,  nor  any  responsibility  for  the  solvency  or  ultimate 
success  of  his  insurance.  On  the  contrary  he  secures  an  untrammeled 
right  to  use  his  agency  and  his  subscribers'  money  as  may  best  further 
his  own  interests,  regardless  of  their  interests.  It  is  true  that  the 
contract  often  provides  for  an  advisory  committee;  but  it  provides, 
either  expressly  or  in  effect,  that  the  members  of  such  committee 
shall  be  selected  by  the  attorney,  instead  of  being  duly  elected  by 
the  subscribers,  and  shall  be  dependent  upon  his  discretion  for  their 
remuneration;  and  it  is  carefully  drawn  so  as  not  to  give  even  that 
"hand-picked"  committee  any  right  to  supervise  or  control  the  opera- 
tions of  the  exchange. 

Obviously  this  is  fine  for  the  attorney.  But  what  do  the  sub- 
scribers get  back  in  return  for  their  blind  trust?  That,  of  course, 
will  depend  upon  the  personality  of  the  attorney,  since  he  may  do 
what  he  pleases  with  his  subscribers'  money.  If  he  is  honest  and 
expert,  collects  premiums  high  enough  not  only  to  pay  losses  due 
but  also  to  maintain  reserves  sufficient  to  cover  all  outstanding  lia- 
bilities, liquidated  and  unliquidated,  due  and  deferred,  and  keeps  his 
funds,  books,  etc.,  so  that  they  will  be  accessible  to  policyholders  in 
the  event  of  his  death  or  otherwise,  the  subscribers  may  get  what 
they  expect.  But  if,  on  the  other  hand,  in  order  to  keep  his  premium 
rates  down  low  and  thereby  to  increase  his  subscriptions  and  con- 
sequently his  commissions,  he  permits  the  deferred  liabilities  to  ac- 
cumulate until  he  can  no  longer  meet  them  without  raising  his 
premiums  to  rates  his  subscribers  will  not  stand,  what  then?  The 
attorney  has  nothing  to  fear  from  such  a  contingency.  He  can 
calmly  shut  up  shop  and  quit,  content  with  his  past  profits,  for  he 
has  no  responsibility  for  any  tangle  in  which  he  may  involve  his  sub- 
scribers. What  then  would  be  the  mutual  rights  and  liabilities  of 
the  subscribers? 

Of  course  the  answer  to  that  question  will  depend  upon  the  terms 
of  the  contract;  and  the  general  form  of  contract  hereinabove  set 
forth  is  only  one  of  an  infinite  number  of  possible  forms  that  the 
attorney-in-fact  may  devise.  Actually  many  different  forms  are  in 
vogue.  And  they  are  frequently  changing;  because  it  is  easy,  as  soon 
as  the  tricks  in  one  form  become  apparent  to  the  public,  to  resort 
to  some  other  form.  But  it  will  be  sufficient  for  illustration  to  study 
the  results  under  the  form  at  present  apparently  prevailing,  which 
most  strictly  limits  the  subscriber's  liability  as  an  insurer,  if  the 
reader  will  realize  that  howsoever  that  form  may  be  varied  from 

9 


there  will  be  no  gain  for  the  subscribers  collectively,  though  it  may 
greatly  alter  their  individual  rights  and  risks,  so  long  as  the  attorney- 
in-fact  reserves  to  himself  the  uncontrolled  management  of  operations 
and  large  commissions  upon  gross  premiums,  without  assuming  any 
material  risks  or  obligations,  and  that  it  is  easy  for  an  expert  attorney 
to  draw  a  contract  so  that  it  will  seem  to  laymen  to  provide  every- 
thing imaginable  for  the  protection  of  subscribers  and  yet  effectually 
do  nothing  of  the  kind. 

In  this  connection  it  should  always  be  borne  in  mind  that  each 
subscriber  is  not  only  an  insured  but  also  an  insurer.  On  the  one 
hand,  each  of  his  co-subscribers  may  owe  him  something  as  indemnity 
for  his  losses;  but,  on  the  other  hand,  he  may  owe  each  of  them 
something  on  account  of  their  respective  losses.  Consequently  when 
he  has  recourse  against  them  for  indemnity,  many  of  them,  in  turn, 
may  have  valid  claims  against  him  for  indemnity.  How,  in  such  a 
mix-up,  can  he  recover  the  indemnity  due  him?  And  how  about 
what  he  in  turn  owes  them?  But  before  taking  up  that  problem, 
it  is  desirable  to  notice  how  it  is  affected  by  the  special  features  of 
workmen's  compensation. 


workmen's  compensation 


Under  the   workmen's  accident   compensation   laws   an   employer 
may  become  liable  to  his  workmen  and  their  dependents  for  weekly 
payments  continuing  during  many  years  or,  in  some  States,  for  life. 
Under  nearly  all  those  laws,  the  employer  is  not  discharged  because 
he  has  insured  his  liability ;  but  his  insurance  carrier  becomes  bound 
either  to  make  such  payments  for  him,  leaving  him  still  obligated  if 
it  fails  to  do  so,  or  to  indemnify  him  for  such  payments  when  and 
as  he  makes  them.     Consequently  when  an  insured  employer  suffers 
a  loss  whereby  he  becomes  liable  contingently  for  some  thousands  of 
dollars  in  compensation,  his  insurance  carrier  does  not  become  obli- 
gated to  pay  the  capitalized  value  of  such  liability  at  once,  but  only  to 
indemnify  him  as  to  each  payment  when  it  falls  due.     This  makes 
the  employer  interested  not  only  in  the  immediate  solvency  of  his 
insurance  carrier,  but  also  and  equally  in  its  continuing  ability  to 
indemnify  him  up  to  the  date  when  the  last  payment  on  his  insured 
liabilities  may  fall  due.     Where  many  employers,  each  continually 
suffering  compensation   losses  with   deferred   liabilities,   are   insured 
in  a  reciprocal  association,  it  should  be  obvious  that,  if  the  current 
premiums  cover  merely  the  payments  on  liabilities  falling  due  within 
the  current  period,  leaving  the  deferred  payments  upon  accrued  lia- 
bilities to  be  provided  for  in  the  future,  there  will  necessarily  be  a 
mass  of  deferred  liabilities  progressively  accumulating  for  many  years, 
for  which  the  subscribers  will  eventually  become  liable  one  to  another 
in  varying  amounts.     In  that  event  any  subscriber  who  thinks  that 
his  liabilities  to  his  workmen  are  covered  by  his  insurance  will  find 
instead  that  his  rights  as  an  insured  are  approximately  offset  by  his 
liabilities  as  an  insurer.     To  illustrate:     Suppose  that  A,  B  and  C 
associate   for  reciprocal  insurance,  paying  into  the  treasury  of  the 
association  each  year  premiums  sufficient  only  to  cover  the  payments 
of  compensation  to  their  injured  workmen  falling  due  within  that 
year:     At  the  end  of  ten  years  it  may  be  that  A  will  be  liable  for 

10 


compensation  payments  to  become  due  in  the  future  for  past  acci- 
dents to  his  employees  aggregating  $20,000,  that  B  will  be  similarly 
liable  for  $17,000  and  that  C  will  be  similarly  liable  for  $15,000. 
Suppose  that  they  then  dissolve  their  association; — C  will  be  entitled 
to  no  indemnity  from  A  or  B,  but  will  have  to  suffer  his  loss  of 
$15,000  unindemnified,  besides  which  he  will  owe  something  to 
A  and  B.  And  A  and  B  will  each  have  an  unindemnified  loss  of 
$17,000  or  over  to  suffer.  Obviously  that  is  not  insurance,  but 
merely  a  partnership  in  losses.  And  the  same  would  be  true  no 
matter  how  much  larger  might  be  the  membership  of  the  association. 
There  can  be  no  assurance  of  the  amount  due  on  a  policy  unless  a 
responsible  third  party,  without  offsets,  is  liable  therefor,  or  unless, 
in  reciprocal  insurance,  there  are  reserves  covering  the  accrued  lia- 
bilities. The  gross  defect  of  reciprocal  insurance  of  workmen's 
compensation  is  that  neither  the  reciprocal  law,  nor  the  usual  con- 
tracts made  under  that  law,  provide  for  the  maintenance  of  such 
reserves.  Such  exemption  from  the  obligation  to  maintain  adequate 
reserves,  in  conjunction  with  the  fact  that  liabilities  for  compensa- 
tion are  so  extremely  long  deferred,  gives  the  unscrupulous  attorney 
of  a  reciprocal  exchange  an  exceptionally  long  time  to  make  his  money 
and  get  out,  leaving  his  insured  subscribers  and  their  workmen  to 
"hold  the  bag."  Our  American  compensation  laws  have  not  yet 
been  in  effect  long  enough  to  illustrate  the  extraordinary  danger  to 
the  insured  from  speculative  methods  in  this  line  of  insurance;  but 
foreign  experience  has  amply  demonstrated  it.  For  this  reason,  it  is 
publicly  reported,  the  Insurance  Commissioner  of  Massachusetts  has 
condemned  workmen's  compensation  insurance  in  reciprocal  or  inter- 
insurance  associations. 

We  can  now  take  up  the  crucial  question:  Under  the  contract 
above  set  forth,  the  attorney-in-fact  assuming  no  responsibility  to 
see  that  the  losses  insured  by  the  policies  he  issues  will  ever  be  paid 
or  even  to  assist  the  insured  in  securing  their  payment,  what  are  the 
rights  and  liabilities  of  the  policyholders  among  themselves  if  and 
when  the  attorney-in-fact  closes  up  his  exchange,  defaults,  or  other- 
wise throws  them  upon  their  own  resources?  And  what  is  the 
position  of  an  injured  workman  whose  compensation  is  insured  by 
such  a  policy,  if  his  employer  is  then  insolvent? 

THE   REMEDY   ON   A   RECIPROCAL    POLICY 

Where  the  holder  of  a  reciprocal  policy  suffers  a  loss  he  is  ac- 
customed to  look  to  the  attorney-in-fact  for  his  indemnity.  The 
latter  may  pay  it  or  he  may  not.  If  the  loss  be  for  workmen's 
compensation  the  attorney  may  indemnify  the  insured  for  his  com- 
pensation payments  for  some  time  and  then  quit.  If,  then,  a  time 
comes  when  the  attorney  does  not  pay  an  indemnity  due,  or  having 
indemnified  an  insured  for  some  of  his  compensation  payments  quits 
before  completion,  what  is  the  latter's  remedy,  assuming  the  con- 
tract to  be  as  hereinbefore  stated?  He  has  no  effective  remedy 
against  the  exchange;  for  it  is  merely  a  place  and  not  a  person  or  a 
corporation.  He  cannot  successfully  sue  the  attorney-in-fact;  because 
the  latter  has  hedged  himself  against  all  personal  liability.  Practically 
he  can  seldom  reach  the  reserve  funds,  even  if  there  then  be  any; 

11 


because,    among  other   reasons,   he   has   no   right   to   any   means   of 
finding  out   where  they   are.      He   cannot   compel    the    attorney   to 
assess  his  co-subscribers ;  for  though  the  contract  may  give  the  attorney 
the  right  to  levy  assessments,   it  does   not   obligate   him   to  do  so. 
Consequently   the   policyholder's   only   recourse   generally   is   against 
his  co-subscribers  directly.    However,  he  cannot  have  recourse  against 
all  of  them  at  once,  because  by  his  contract  he  must  first  prosecute 
to  a  finish  a  test  suit  against  one  before  he  can  sue  any  of  the  others. 
Moreover,  before  he  can  sue  them  he  must  first  find  out  their  various 
names  and  addresses,  together  with  evidence  to  prove  that  they  were 
subscribers  to  the  exchange  at  the  time  when  his  loss  occurred  or 
were  otherwise  parties  to  his  policy;  and,  as  has  been  seen,  under  the 
reciprocal  law,  the  attorney  is  relieved  from  any  obligation  to  fur- 
nish such  information.     Even  if  he  be  successful  in  obtaining  such 
information  and  in  securing  judgment  in  his  test  suit,  his  troubles 
have  only  begun.     Supposing  that  his  total  claim  is  for  $30,000  and 
that  there  are  300  co-subscribers,  then  each  of  the  latter  severally 
owes  him  on  the  average  only  $100,  subject,  moreover,  possibly  to 
an  offset  which  may  or  may  not  exceed  that  amount ;  and  to  recover 
the  total  amount  due  him  he  may  have  to  collect  all  that  is  due  from 
each  and  all  of  such  co-subscribers.     Some  of  them  may  have  ceased 
to  exist  or  be  unable  to  pay.     To  get  an  effective  judgment  against 
each  of  the  others  who  can  but  will  not  pay  he  may  have  to  sue  in 
many  courts  and  in  many  States,  so  that  the  cost  of  the  litigation 
may  and  probably  will  approximate  if  it  does  not  exceed  the  amount 
of  his  claim.     If  any  of  the  other  subscribers  so  sued  have  anything 
due  them  on  their  policies  they  may,  of  course,  offset  the  amounts 
thereof  in  such  suits,  so  that  many  of  such  suits  may  prove  to  be 
veritable  boomerangs.     That  such  small  and  doubtful  claims  are  sel- 
dom worth  ten  cents  on  the  dollar  is  well  known  from  common 
experience.    That  they  may  be  worth  practically  nothing  is  indicated 
by  the  reported  experience  of  the  West  Virginia  firm  cited  at  the 
beginning  of  this  paper. 

Where  the  insurance  is  for  workmen's  compensation  the  position 
of  a  reciprocal  policyholder  seeking  to  recover  indemnity  due  from 
his  co-subscribers  would  be  even  worse.  Suppose  that  he  has  suffered 
an  insured  loss  aggregating  $3,000,  not  presently  payable,  but  obligat- 
ing him  to  weekly  payments  for  many  years  in  the  future — say  for 
$10  a  week  for  300  weeks.  Then,  if  he  has  300  co-subscribers, 
each  of  them  on  the  average  would  become  liable  to  him  for  31/3 
cents  per  week  for  300  weeks.  Of  course  the  policyholder  cannot 
collect  such  picayune  sums  as  they  fall  due.  On  the  other  hand 
he  cannot  safely  wait  until  the  end  of  the  300  weeks  so  as  then  to 
sue  for  the  aggregate  liabilities,  because  the  statute  of  limitations 
might  supervene  and  many  of  his  debtors  might  pass  away  in  the 
meantime.  Exactly  what  he  could  do  under  such  conditions  would 
vary  according  to  circumstances;  but  certainly,  even  if  his  co- 
subscribers  should  have  no  offsets,  he  could  never  collect  his  $3,000 
net  nor  any  material  part  of  it.  If,  on  the  other  hand,  his  co- 
subscribers  generally  should  have  offsets,  as  would  probably  be  the 
case  where  the  insurance  is  for  workmen's  compensation,  a  responsible 
policyholder  with  a  large  sum  due  him  as  indemnity  would  be  in  a 

12 


tangled  maze  of  rights  and  liabilities  from  which  he  would  be 
mighty  lucky  to  extricate  himself  without  still  further  loss.  There- 
fore it  is  obvious  that,  if  the  exchange  breaks  down,  a  reciprocal 
compensation  insurance  policy  is  very  apt  to  become  either  entirely 
or  approximately  worthless. 

But  even  the  foregoing  low  appraisal  of  the  value  of  a  reciprocal 
policy  supposes  that  all  the  subscribers  to  the  exchange  had  power  to 
enter  into  contracts  of  reciprocal  insurance  and  that  all  the  contracts 
involved  are  valid.  Such,  however,  may  not  be  the  case.  Some  of 
the  subscribers  may  be  corporations  of  States  wherein  it  may  be  held 
to  be  ultra  vires  for  a  corporation  to  engage  in  the  business  of  inter- 
insurance.  And  some  of  the  subscriptions  to  the  exchange  may  have 
been  secured  in  States  wherein  the  exchange  had  no  authority  to  do 
business.  Whether  such  subscribers  could  ultimately  escape  liability 
if  fought  through  the  courts  to  a  finish  may  be  doubtful.  But  that 
doubt  and  the  expense  of  recovery  against  them  yet  further  seriously 
reduce  the  probable  value  of  a  policy  in  a  reciprocal  exchange  with 
a  widely  extended  membership. 

So  far  we  have  considered  only  the  remedy  of  a  reciprocal  policy- 
holder on  his  policy.  But  under  the  workmen's  compensation  laws 
the  policyholder's  injured  workmen  also  are  supposed  to  be  secured 
by  the  policy.  If  then  the  policy  may  be  practically  almost  worthless 
to  the  policyholder,  of  what  value  would  it  be  as  security  to  his 
workmen  in  the  event  of  his  insolvency?  Theoretically  it  would  be 
equally  valueless.  Practically  it  would  be,  if  possible,  still  more 
valueless;  for  the  average  workman  is  peculiarly  unable  to  pursue 
the  long,  multitudinous  and  expensive  litigation  that  might  be  neces- 
sary to  collect  on  it. 

THE    LIABILITY    OF    A    SUBSCRIBER 

As  has  been  seen,  the  usual  reciprocal  contract  so  limits  the  lia- 
bility of  a  subscriber  and  creates  so  many  obstacles  in  the  way  of 
collecting  from  him,  that,  save  in  the  event  of  some  slip,  his  risk 
of  liability  seems  to  be  trifling.  But  even  if  that  be  true  it  is  as 
broad  as  it  is  long.  For  if  the  subscriber  be  practically  immune  from 
liability  as  an  insurer,  his  rights  and  the  rights  of  his  employees  as 
insured  will  be  correspondingly  precarious. 

However,  such  immunity  is  far  from  certain.  Two  contingencies 
are  to  be  feared :  First.  In  those  States  wherein  no  special  law 
is  in  force  authorizing  inter-insurance,  subscribers  to  reciprocal  ex- 
changes incur  the  danger  of  being  held  liable  as  partners,  in  which 
event  any  conspicuously  responsible  subscriber  might  be  selected  as  a 
target  by  many  of  the  policyholders  and  forced  to  pay  all  of  their 
claims  in  full.  And  the  same  might  be  the  consequence  if  the  re- 
ciprocal law  of  the  subscriber's  State  should  be  declared  unconstitu- 
tional, as  was  the  first  reciprocal  law  of  Missouri.  Second.  The 
power-of-attorney  the  subscriber  executes  may  not  be  framed  in 
the  most  immunity  bearing  form,  as  assumed  above.  It  may, 
on  the  contrary,  only  limit  his  liability  to  his  co-subscribers  to  the 
amount  of  one  annual  premium  on  any  one  loss  or  on  any  one  policy, 
in  which  event,  if  his  premium  be  large  and  he  have  many  co- 
subscribers,  he  may  find  himself  liable  in  large  amounts  to  many  of 

13 


them — in  the  aggregate  possibly  for  some  hundred  times  his  annual 
premium.  Or  it  may  even  be  that  the  power-of-attorney  is  so  de- 
fectively drawn  as  to  contain  no  effective  limitation  at  all  upon  his 
liability,  in  which  event  he  would  be  liable  for  just  as  much  as  if  he 
were  a  partner,  in  spite  of  the  reciprocal  law.  Consequently,  what- 
soever may  be  the  probabilities,  there  is  always  some  risk  of  ruinous 
liability  in  subscribing  to  a  reciprocal  exchange. 

The  foregoing  relates  only  to  the  subscriber's  liability  to  his  co- 
subscribers.  That,  however,  does  not  exhaust  his  risks  of  liability; 
for  his  power-of-attorney  may  involve  him  in  very  serious  liabilities 
to  his  attorney-in-fact.  As  has  been  seen,  the  usual  or,  at  least,  a 
common  power-of-attorney  authorizes  the  attorney  to  deduct  some 
fixed  percentage  of  the  subscriber's  gross  premiums  for  his  remunera- 
tion and  expenses,  and  then  goes  on  to  provide  that  either  party  may 
terminate  the  contract  upon  notice,  upon  which  termination  the 
subscriber's  equitable  pro  rata  part  in  the  premium  fund  shall  be 
determined  by  the  attorney  and  returned  to  the  subscriber.  Such 
provisions  are  "baits  to  catch  suckers."  For  example,  the  attorney 
may  issue  a  three  years'  policy,  collecting  the  first  year's  premium 
or  deposit  in  cash,  and  the  two  later  years'  premiums  in  notes.  He 
may  then  at  once  deduct  his  stipulated  percentage  of  the  total, 
which — if  such  percentage  be  30% — would  be  90%  of  the  cash.  If, 
then,  a  month  later,  either  the  attorney  or  the  subscriber  should 
terminate  the  contract,  what  would  the  former  graciously  determine 
to  return  to  the  latter  as  the  latter's  equitable  pro  rata  part  in  the 
premium  funds?  Under  such  circumstances  the  subscriber  would 
be  lucky  if  he  should  get  back  his  notes  and  lose  only  his  first  year's 
premium.  But  attorneys  need  not  content  themselves  with  such 
modest  opportunities  in  this  line  of  graft.  By  adding  some  innocent 
looking  clauses  to  the  power-of-attorney  and  an  artfully  drawn  sur- 
render-value table  to  the  policy,  the  attorney-in-fact  may  put  himself 
in  a  position  wherein,  if  he  can  secure  advance  premium  notes  from 
his  subscribers,  he  can  not  only  keep  all  the  cash  but  also  enforce  the 
notes  and  yet  confiscate  the  insurance.  According  to  Hon.  John  S. 
Patterson,  quoted  above,  abuses  such  as  just  described  are  not  only 
possible  but  also  have  been  common  in  his  part  of  the  country. 

EXEMPTION    FROM   TAXATION 

Not  content  with  exemption  from  supervision  by  the  public  author- 
ities and  from  regulations  to  prevent  impositions  upon  the  public, 
promoters  of  reciprocal  insurance  often  demand  exemption  from 
taxation.  Other  insurance  carriers  are  taxed  right  and  left,  the 
aggregate  taxes  on  the  stock  companies  in  some  States  mounting  up 
to  as  much  as  3%  of  their  annual  premiums.  And  in  addition  gen- 
erally their  agents  also  are  taxed.  In  the  face  of  this  burden  upon 
their  competitors  the  reciprocals  have  the  hardihood  to  ask  that 
they  be  let  off  each  with  one  small  license  fee.  Naturally  few  States 
have  granted  any  such  sweeping  exemption;  but  in  many  States 
substantial  discriminations  have  been  secured  in  their  favor.  Upon 
what  ground  can  the  claim  for  any  such  discrimination  reasonably 
be  based?  Not  upon  the  ground  that  reciprocal  insurance  is  so 
superior  to  other  forms  of  insurance  that  it  is  expedient  for  the  State 

14 


•  •  •  •  .• 
•  •  •    ••»•*, 


.,.♦«••       •  • "         •  •  •! 


to  promote  it  by  pecuniary  favors;  for,  as  has  been  seen,  reciprocal 
insurance,  as  at  present  unregulated,  has  had  a  bad  record  and  lends 
itself  exceptionally  to  fraudulent  practices.  The  argument  of  its 
promoters  is  that  the  premiums  and  funds  of  a  reciprocal  exchange 
should  not  be  taxed  because  the  subscribers  are  not  in  the  business 
for  profit.  But  the  policyholders  in  stock  companies  are  not  in  the 
business  for  profit,  and  yet  their  premiums  are  heavily  taxed.  On 
the  other  hand,  if  a  stock  company  should  be  taxed  because  it  owns 
the  business  and  operates  it  for  profit,  so  also  should  the  attorney-in- 
fact  of  a  reciprocal  exchange,  for  he  also  owns  the  business  and 
operates  it  for  profit.  The  only  distinction  between  them,  in  this 
respect,  is  that  the  stock  company  is  financially  responsible,  assumes 
all  risks  and  provides  certain  indemnity  in  return  for  a  mere  chance 
of  profit,  whereas  the  attorney-in-fact  of  a  reciprocal  is  irresponsible 
and  assumes  no  risk,  but  merely  redistributes  risks  uncertainly  among 
his  subscribers,  in  return  for  large  and  certain  profits.  It  is  plain, 
therefore,  that  there  should  be  no  discrimination  in  the  rate  of  taxa- 
tion between  them,  or,  if  any,  that  it  should  be  in  favor  of  the 
stock  companies. 

CONCLUSION 

As  has  been  seen,  reciprocal  or  inter-insurance  is  a  novel  form  of 
insurance,  radically  different  from  Lloyds  insurance.  It  resembles 
mutual  insurance  in  that  the  subscribers  bear  all  the  risks;  but  it 
differs  in  that  a  third  party  owns,  controls  and  manages  the  busi- 
ness, operates  it  for  his  own  benefit,  and  derives  profits  from  it. 
It  resembles  stock  company  insurance  in  that  a  third  party  owns, 
controls  and  manages  the  business  of  providing  insurance  for  the 
policyholders;  but  it  differs  in  that  such  third  party  does  not  assume 
the  risks  nor  in  any  way  become  responsible  for  the  payment  of  the 
indemnity.  As  a  consequence  it  is  subject  to  many  of  the  dangers 
and  abuses  peculiar  to  each  of  those  other  forms  of  insurance,  and 
yet  it  possesses  the  strength  of  no  one  of  them.  Therefore,  so  far 
from  meriting  exemption  from  all  the  regulations  imposed  upon 
any  of  those  other  forms  of  insurance,  reciprocal  insurance  requires 
all  the  regulations  common  to  all  of  them  and  many  of  the  special 
regulations  applicable  to  only  one  of  them. 

Nevertheless  many  reciprocal  promoters  demand  practically  com- 
plete exemption  from  all  such  regulations,  and  have  secured  it  where- 
ever  the  standard  reciprocal  law  is  in  force.  Where  they  cannot 
get  that  they  seek  to  compromise.  There  is  no  right  nor  reason  for 
any  compromise.  For  even  elementary  protection  to  the  public  against 
prevalent  frauds  and  abuses  reciprocal  insurance  should  be  subjected 
to  the  following  regulations  at  the  least: 

The  powers-of-attorney  and  the  policies  of  every  reciprocal  ex- 
change should  be  subject  to  the  approval  of  the  Insurance  Com- 
missioner as  to  form. 

The  attorney-in-fact,  before  beginning  business,  should  be  required 
to  furnish  ample  security  for  the  proper  performance  of  his  duties; 
and  thereafter  he  should  be  required  to  keep  his  funds  and  reserves 
deposited  with  some  designated  and  responsible  depository. 

15 


„    ti 


1  «*« 


He  should  be  required  to  maintain  the  same  reserves  as  a  stock 
company,  under  the  supervision  of  the  Insurance  Commissioner. 

He  should  be  required  to  report  annually  to  the  Insurance  Com- 
missioner, not  in  the  present  deceptive  form,  but  setting  forth  a 
proper  balance  sheet  of  his  business,  showing  particularly  the  amount 
of  his  outstanding  liabilities,  calculated  according  to  prescribed 
actuarial  principles. 

He  should  be  required  to  keep  proper  books  of  account  at  his 
exchange,  together  with  complete  lists  of  his  subscribers,  accessible 
to  his  policyholders  in  case  of  need. 

He  should  be  forbidden  to  carry  any  single  risk  in  excess  of  some 
reasonable  proportion  of  his  annual  premiums,  without  approved 
reinsurance. 

A  real  advisory  committee  should  be  provided  for,  to  be  elected 
by  the  subscribers,  under  provisions  of  law  to  assure  a  fair  election, 
with  full  power  of  supervision  and  audit  and  with  sufficient  power 
of  control  to  stop  abuses. 

The  Insurance  Commissioner  should  be  given  not  only  full  power 
of  examination  and  supervision  but  also  authority  to  secure  the  ap- 
pointment of  a  receiver  to  wind  up  a  reciprocal  exchange  for  the 
benefit  of  its  policyholders,  if  he  discovers  that  insolvency  is  certainly 
impending  or  that  the  attorney-in-fact  is  fraudulently  misconducting 
the  business. 

The  business  of  every  reciprocal  attorney-in-fact  should  be  taxed  at 
the  same  aggregate  rate  as  the  business  of  stock  companies. 

In  favor  of  the  foregoing  proposed  regulations  it  can  be  said  that 
none  of  them  would  interfere  with  the  normal  conduct  of  the  opera- 
tions of  a  reciprocal  exchange  along  honest  lines  and  that  none  of 
them  would  discriminate  against  reciprocal  insurance  in  competition 
with  other  forms  of  insurance,  and  yet  that  every  one  (with  the 
reasonable  exception  of  the  provision  as  to  taxation)  would  be  to 
the  positive  advantage  of  reciprocal  policyholders,  by  protecting  them 
against  some  common  evil  or  abuse.  What  then  is  the  objection? 
The  fact  that  there  are  honestly  managed  reciprocal  associations  and 
that  some  of  them  may  also  be  so  managed  as  to  meet  the  requirements 
for  security  to  their  subscribers,  is  not  a  valid  objection,  since  that 
objection  would  apply  with  yet  greater  force  to  regulating  any  other 
form  of  insurance.  Therefore  it  is  impossible  to  avoid  the  con- 
clusion that  the  motive  for  the  objection  on  the  part  of  many  of 
the  promoters  of  reciprocal  insurance  is  a  desire  to  make  use  of  the 
opportunities  for  fraud  and  illegitimate  speculation  which  such  ex- 
emptions secure  them. 

New  York,  June,  1916. 

P.  TECUMSEH  SHERMAN. 


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